Competitiveness in the CFA Franc Zone

Transcription

1 WP/7/212 Competitiveness in the CFA Franc Zone Gustavo Ramirez and Charalambos G. Tsangarides

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3 27 International Monetary Fund WP/7/212 IMF Working Paper African Department Competitiveness in the CFA Franc Zone Prepared by Gustavo Ramirez and Charalambos G. Tsangarides 1 Authorized for distribution by Anne-Marie Gulde August 27 Abstract This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the authors and are published to elicit comments and to further debate. This paper reviews the evolution of competitiveness in the CFA franc zone using a proposed comprehensive competitiveness framework. In particular, we examine competitiveness in the WAEMU and CEMAC regions by analyzing the environment and policy components of competitiveness and their quantifiable determinants, including indicators to measure productivity and labor market conditions, prices and costs, macroeconomic performance, business environment, governance, and technology and infrastructure. Our findings suggest that despite some recent improvements particularly for the CEMAC both regions face serious competitiveness challenges when compared to pier groups of countries. In order to become more competitive, raise growth, and improve the quality of life, there is a need for structural reform to improve productivity, reduce factor costs, and create the right business, legal, and political environment to attract economic activity. JEL Classification Numbers: F4, F33, O57, C43. Keywords: Competitiveness, CFA franc, WAEMU, CEMAC. Authors Addresses: gramirez@imf.org; ctsangarides@imf.org. 1 We would like to thank Anne-Marie Gulde-Wolf for her guidance throughout the project. We are also grateful for helpful comments and suggestions received from colleagues in the African Department, particularly the WAEMU and CEMAC members country teams. All remaining errors are, of course, ours.

4 2 Contents Page I. Introduction...4 II. The Competitiveness Framework...5 III. Competitiveness Overview: Sustainable Growth and Quality OF Life...7 A. GDP Performance...7 B. Quality of Life...9 IV. Environment and Conditions...1 A. Productivity and Labor Markets...1 B. Costs and Prices...12 C. Macroeconomic Performance...19 V. Policy...22 A. Business Environment...22 B. Governance...27 C. Technology and Physical and Human Capital...3 VI. Conclusion...32 Tables 1. WAEMU and CEMAC: Real Effective Exchange Rate and Components a. CEMAC: Doing Business Indicators, b. WAEMU: Doing Business Indicators, Diagram 1. Elements of Competitiveness...6 Figures 1. Real GDP Growth Real GDP Growth Real Per Capita GDP Growth Per Capita GDP Per Capita PPP GDP Per Capita GDP Human Development Index Life Expectancy GINI Coefficient CEMAC and WAEMU: Productivity Index Demographics and Labor Market a. CEMAC: Exchange Rates and Relative Prices...14

5 3 12b. WAEMU: Exchange Rates and Relative Prices a. CEMAC: Real Effective Rates of Member Countries b. WAEMU: Real Effective Exchange Rates of Member Countries a. CEMAC: Internal Real Exchange Rate vs. Real Effective Exchange Rate b. WAEMU: Internal Real Exchange Rates vs. Real Effective Exchange Rate a. CEMAC: CPI-Based vs. Labor Cost-Based REER b. WAEMU: CPI-Based vs. Labor Cost-Based REER a. CEMAC: CPI vs. Tertiary Deflator based REER b. WAEMU: CPI vs. Tetiary Deflator-Based REER a. CEMAC: Nominal Effective Exchange Rate b. CEMAC: Real Effective Exchange Rate a. WAEMU: Nominal Effective Exchange Rate b. WAEMU: Real Effective Exchange Rate a. CEMAC: Real Wage Index b. WAEMU: Real Wage Index a. CEMAC: Ration of Exports to Selected Groups Total Imports...2 2b. WAEMU: Ratio of Exports to Selected Groups Total Imports (In percent) a. CEMAC: Export Patterns (in percent) b. WAEMU: Export Patterns (in percent) Exports of Goods and Services (Percent of GDP) Foreign Direct Investment (US$, billions) Foreign Direct Investment (Percent of GDP WAEMU: Export Performance by Product, a. CEMAC: Terms of Trade, Real Oil Price and Exchange Rates b. WAEMU: Terms of Trade, Export Prices and Exchange Rates a. CEMAC: Profitability Indicator Export Price Index/Wage Index b. WAEMU: Profitability Indicators CEMAC: Profitability Indicator Export Price Index/Tetriary GDP Deflator CEMAC and WAEMU: Doing Business Indictors, Governance Indicators, Infrastructure and Technology Indicators Human Capital Indicators CEMAC and WAEMU Relative to Sub-Saharan Africa (Percent of Total SSA) CEMAC and WAEMU Relative to Low and Middle Income Countries...33 Appendices Appendix A...35 Appendix B...37 References...39

6 4 I. INTRODUCTION The 1994 devaluation of the CFA franc was a result of a prolonged deterioration of the terms of trade of the countries of the CFA franc zone, a steep rise in the labor costs of those countries, and a nominal appreciation of the French franc against the U.S. dollar, all of which resulted in an overvalued exchange rate. 2 The devaluation was instrumental in making CEMAC and WAEMU countries more competitive, and, reinforced by prudent macro policies and structural reforms, helped GDP return to positive growth rates. 3 This experience has shown that maintaining the fixed exchange rate regime in the CFA franc region requires careful attention to competitiveness and suggests that an assessment of whether the competitiveness gains since the devaluation have been preserved or eroded is warranted. Generally, competitiveness can be defined as the ability of a country to operate efficiently and productively in relation to other countries while keeping living standards for its citizens high. From a macroeconomic perspective, competitiveness can be viewed as the degree to which a nation can produce goods and services that meet the test of international markets while simultaneously expanding the real incomes of its people over the long term under free trade and fair market conditions (OECD, 1992). At the microeconomic level, competitiveness is the capacity to sell products profitably. To be competitive, a firm and by extension, a country must be able to charge lower prices or offer products of better quality (or with better service) than its competitors (Cockburn et al., 1998). Using a comprehensive competitiveness framework we review the evolution of competitiveness in the CEMAC and WAEMU regions and benchmark their performance against other countries and comparator groups. Our main findings are as follows. First, the evidence of the evolution of competitiveness in the two regions suggests that there are some areas where competitiveness has improved (particularly export profitability and market share in CEMAC driven by oil market developments) but others where competitiveness has worsened (including, for both regions, real effective exchange rate appreciation and poor scores on cost of doing business and governance). Second, there are serious competitiveness gaps when CEMAC and WAEMU are compared with their peer groups of countries, particularly in the areas of business environment, governance, and human capital. Finally, in order to overcome competitiveness challenges in the regions there is a need for structural reform policies in both regions to boost productivity, reduce excessive factor costs, diversify the base of production, and create the conditions to attract higher domestic and foreign private investment in all sectors of economic activity. 2 A fixed exchange rate for the CFA franc (CFAF) was adopted by the CFA franc zone countries in The franc zone countries include the eight members of the West African Economic and Monetary Union (WAEMU) and the six members of the Central African Economic and Monetary Union (CEMAC). 3 The 5 percent devaluation in January 1994 was the only change in the exchange rate peg. Since the introduction of the euro in 1999, the CFAF has been pegged to the euro at CFAF per 1.

7 5 The rest of the paper is organized as follows. Section II presents the thinking about competitiveness and proposes our competitiveness framework. Section III reviews progress in achieving sustainable growth and improvements in the quality of life in CEMAC and WAEMU. Section IV presents the environment and conditions affecting competitiveness. Section V presents policy inputs affecting competitiveness. Section VI concludes and provides policy implications. II. THE COMPETITIVENESS FRAMEWORK Countries are increasingly evaluating their competitiveness in global markets, and international competitiveness comparisons are conducted yearly. 4 National competitiveness is particularly important for small open economies aiming to provide people with the opportunity to improve their living standards and quality of life, by providing employment and raising incomes through productivity gains. While productivity gains are necessary, the process of raising productivity may differ across countries. Competitiveness can be analyzed on many dimensions. The World Economic Forum s annual Global Competitiveness Report (GCR) separates countries by stage: factor-driven, efficiencydriven, or innovation-driven. Countries in the factor-driven stage of development have four main concerns: well-functioning public and private institutions, appropriate infrastructure, a stable macroeconomic framework, and good health and primary education. On the other hand, the four main factors the World Competitiveness Yearbook (WCY) uses in analyzing countries are economic performance, government efficiency, business efficiency, and infrastructure. Finally, the competitiveness pyramid of the Irish National Competitiveness Council (NCC) distinguishes between the inputs to national competitiveness over which policymakers can have greater control and the essential conditions. The common theme among all these analyses is that competitiveness is about identifying the elements necessary to ensure sustainable growth and improve living standards. Therefore, building on the Ireland NCC approach, we view competitiveness as consisting of two interlinked components or conditions, environment and policy. 5 The environment component includes measures of costs, prices, exchange rates, and wages and their impact on the ability of the country to export enough goods and services to pay for its import requirements and maintain full employment. The policy component includes factors that contribute to better business performance through innovation and productivity, such as the business environment, 4 Some countries, among them like the United States, Ireland, Croatia, Greece, the Philippines, and Tunisia maintain advisory bodies or special government agencies that handle competitiveness issues. Yearly competitiveness surveys are conducted by the World Economic Forum (Global Competitiveness Report); the International Management Development Institute (World Competitiveness Yearbook); and the World Bank (Doing Business). 5 Models used in the Global Competitiveness Report and World Competitiveness Yearbook can, in a sense, be embedded in the Ireland model, which we consider more comprehensive for our analysis.

8 6 governance, and physical and human capital. There are also useful and important links between the two components. For example, the determinants of the environment namely, prices and costs, macroeconomic performance, and productivity and labor markets are the conditions of competitiveness that good policies create. Similarly, policies are both responses to and results of the current environment. Diagram 1 summarizes the factors that affect national competitiveness and presents growth and quality of life as the ultimate goals of competitiveness. Diagram 1. Elements of Competitiveness GROWTH AND QUALITY OF LIFE COMPETITIVENESS ENVIRONMENT POLICY Productivity Labor Market Prices and Costs Macro Performance Business Environment Governance Technology Infrastructure Human Capital

9 7 Our analysis traces sequentially environment and policy factors and their determinants to provide a comprehensive story of competitiveness in the CFA franc zone. Our work is complementary to other competitiveness reports on Africa notably the 27 World Economic Forum s Africa Competitiveness Report but at the same time, more comprehensive in its coverage of all fourteen countries of the CFA franc zone and more focused on the characteristics of the WAEMU and CEMAC regions. 6 Our work differs from the on-going work of the IMF s Policy Development and Review (PDR) Department to develop a template to assess competitiveness and real exchange rate misalignments in low-income countries. We avoid generalizing competitiveness indicators in some form of a metric to assess competitiveness. Rather, to avoid synthesizing results from a variety of indicators, we try to capture a more global view of the two regions competitiveness by comparing how each region fares vis-à-vis the other and the comparator groups. Before proceeding, it is useful to recognize the data limitations associated with our analysis, as it is the case in many developing country competitiveness analyses. 7 While these limitations do exist, nevertheless, we believe that they do not reduce the usefulness of our analysis. The multiplicity of competitiveness indicators examined allows the flexibility to look at a more comprehensive picture of competitiveness and reduces the errors that may result from any data limitations. III. COMPETITIVENESS OVERVIEW: SUSTAINABLE GROWTH AND QUALITY OF LIFE A. GDP Performance Growth since the devaluation has varied within the CFA franc zone and has been uneven between WAEMU and CEMAC. It has been linked to external price exchange rate developments, as well as the structural characteristics of economies in the regions. Oil market developments including variations in world oil prices and country-specific positions in the life cycle of oil production have dominated the CEMAC economies. 8 Since 1994, real GDP growth in the CEMAC averaged about 5 percent of GDP (with a pronounced drop in 1999 as oil prices plunged) while in the WAEMU, growth has been lower and more volatile, averaging about 4 percent. Relative to the averages for sub-saharan Africa (SSA), real per capita growth has been strong. Real growth in both regions has exceeded growth in Latin America and OECD, and in the CEMAC growth has exceeded that of emerging Asia and for 21 6 was almost 6 The 27 Africa Competitiveness Report covers only 5 of the 16 countries of the WAEMU and CEMAC regions. 7 In fact, many competitiveness analyses exclude developing counties due to data availability and reliability issues. In other cases, as for example in the 27 Global Competitiveness Report (page xxv), the reader is cautioned that for some countries survey data have high within-country variance; until the reliability of survey responses improves with future educational efforts and improved sampling in these countries, their rankings should be interpreted with caution. 8 Of the six CEMAC members, only the Central African Republic does not produce oil. Petroleum constitutes the bulk of the region s export receipts and more than half its budgetary revenue.

10 8 double the SSA average (Figures 1 and 2). However, real growth in per capita terms was not as favorable for either region, with WAEMU growing at lower than SSA rates and CEMAC just about the SSA rates (Figure 3). Disparities between WAEMU and CEMAC result from higher population growth rates in WAEMU and higher growth in the CEMAC due to oil market developments. 1 Figure 1. Real GDP Growth (Annual, percent change) 2 Figure 2. Real GDP Growth (Percent) Emerging Asia CEMAC OECD Emerging ASIA Latin America SSA CEMAC WAEMU Source: IMF, World Economic Outlook; and African Department database. -5 Sub-Saharan Africa WAEMU Latin America OECD Source: IMF, World Economic Outlook Figure 3. Real Per Capita GDP Growth (Annual, percent change) Figure 4. Per-capita GDP (US$, thousands) OECD (Right scale) Latin America OECD Emerging ASIA Latin America SSA CEMAC WAEMU Emerging Asia CEMAC Sub-Saharan Africa WAEMU Source: IMF, World Economic Outlook; and African Department database. Source: IMF, World Economic Outlook OECD (Right scale) Emerging Asia Figure 5. Per-capita PPP GDP (US$, thousands) CEMAC Latin America Sub-Saharan Africa WAEMU Figure 6. Per-capita GDP (Index 1995=, US$) Sub-Saharan Africa OECD Emerging Asia WAEMU CEMAC Latin America Source: IMF, World Economic Outlook. Source: IMF, World Economic Outlook.

11 9 In nominal terms WAEMU and CEMAC output per capita does not compare favorably with peer groups. WAMU and CEMAC rates are below other developing country groups, including Latin America and emerging Asia, both in U.S. dollar and purchasing power parity (ppp) adjusted terms (Figures 4 and 5). Despite the progress CEMAC has been making (Figure 6), its per capita GDP is barely above the SSA average and is below comparator groups both in dollar and ppp terms. B. Quality of Life A key objective of competitiveness is to ensure that the quality of life improves, a concept that goes beyond growth rates and material living standards. We measure quality of life using the 1. Figure Human UN Human Development Index (HDI), which.9 Development Index (=less, 1=more developed) combines measures of life expectancy, literacy,.8 and income, and a measure of inequality, the.7 Gini coefficient..6 In terms of HDI, CEMAC and WAEMU ranks below OECD and other comparator groups like emerging Asia and Latin America, and the CEMAC region performs only marginally above the SSA average (Figure 7). All WAEMU countries rank in the low human development part of the HDI, and four WAEMU countries (Guinea-Bissau, Burkina Faso, Mali, and Niger) rank among the five lowest in the index, with virtually no improvement since 2. CEMAC countries perform only marginally better, with Chad and the Central African Republic (CAR) in the bottom seven of the index and the rest rated as in middle human development. At about 5 years, life expectancy for both WAEMU and CEMAC ranks much below the averages for emerging Asia and Latin America, both of which are catching up fast with the OECD (Figure 8). Finally, income inequality as measured by the Gini coefficient is higher in CEMAC than WAEMU, about at the SSA average, and above emerging Asia and the OECD (Figure 9) OECD Emerging Asia Latin America SSA CEMAC WAEMU Source: United Nations, Human Development Report, 26. OECD Figure 8. Life Expectancy (Years) Emerging Asia Latin America SSA CEMAC WAEMU Source: United Nations, Human Development Report, 26. In summary, recent increases in GDP growth rates in both regions have for the most part failed to translate into improvements in the quality of life indicators and sustainable improvements in living standards.

12 1 IV. ENVIRONMENT AND CONDITIONS A. Productivity and Labor Markets Productivity is a driver of economic growth and important as both determinant and indicator to competitiveness. In general, productivity is a measure relating a quantity or quality of output to the inputs required to produce it; it often refers to labor productivity, which can be measured by quantity of output per time spent or number of workers employed Figure 9. GINI Coefficient (=less, = more unequal income distribution) First, we examine the overall productivity of WAEMU and CEMAC using real per capita GDP as a proxy for output per worker. The real per capita GDP growth estimates in Figure 3 suggest that WAEMU productivity is the lowest among all developing country comparator groups including SSA, with the trends indicating a decline since CEMAC productivity is at about the SSA level and has been improving since OECD Emerging Asia Latin America SSA CEMAC WAEMU Source: United Nations, Human Development Report, 26. Figure 1. CEMAC and WAEMU: Productivity Index (Real GDP per capita, vis-à-vis main trading partners) CEMAC Next, we construct a productivity index of each region s real per capita GDP against its partner countries, which can give another dimension of productivity. 1 Looking at this 1..8 WAEMU measure, for both WAEMU and CEMAC there is a persistent decline in productivity Source: IMF, World Economic Outlook. since the late 199s, with both productivity indices at about the same levels in 26 (Figure 1) Human and physical capital and resources, technology and innovation, and the macroeconomic and institutional environment determine productivity. We discuss the environment here section and because they are influenced by policy, we discuss human and physical capital, resources, technology, and innovation are influenced by policy in Part IV. 1 This measure is typically used in equilibrium real effective exchange rate analyses. The productivity index is constructed as the ratio of real per capita GDP relative to each region s main trade partners (in logarithmic terms), normalized for each region to 1 in 2. See Abdih and Tsangarides (26) for more details.

13 11 The cost of inputs in the production process is another determinant of competitiveness. A measure of these costs that also measures international competitiveness is the unit labor cost (ULC), which essentially combines labor Figure 11. Demographics and Labor Market 2.7 Population Growth (Annual percent) cost and productivity. The International Labor 2.6 Organization s Key Indicators of the Labor LMI (1.5) Market Program (KILM) gives ULC 2.5 USA (1.2) comparisons mainly for developed economies, because (i) for developing countries 2.4 information on labor compensation is inadequate, particularly on employers costs 2.3 (such as social security contributions), and (ii) 2.2 in developing countries there is a relatively CEMAC WAEMU Sub-Saharan Africa large share of self-employed persons operating 82 Total Labor Participation in the informal sector, which complicates the (Percent ages 14-65) analysis of ULCs We therefore focus on measures of labor market conditions, particularly supply With no data available on unemployment rates, we examine other demographic and labor market characteristics in WAEMU and CEMAC (Figure 11). For , the average population growth rate in WAEMU was about 2.7 percent, higher than both CEMAC and SSA, almost twice as high as in lower and middle-income (LMI) countries and Latin America, and more than twice as high as the East Asian countries. In a Malthusian view, these rates do not translate into a larger labor force but into higher resource constraints. At about 79 percent in 24, total labor force participation rates in WAEMU compare favorably to those of SSA (76 percent), LMI countries (71 percent), and Latin American countries (7 percent). While marginally below the SSA rates in 24, female labor force participation in both LMI CEMAC WAEMU Sub-Saharan Africa Female Labor Participation (Percent ages 14-65) LMI CEMAC WAEMU Sub-Saharan 57 Africa Source: World Bank, World Development Indicators, See KILM s Unit labor costs, productivity and international competitiveness available

14 12 WAEMU and CEMAC compares favorably with other groups, including LMI countries (57 percent) and Latin American countries (55 percent). In summary, measured productivity compared with trading partners for both WAEMU and CEMAC has been declining. While high population growth rates exert a resource constraint, some labor market conditions, such as labor force participation, appear promising when contrasted with comparator groups. B. Costs and Prices Because they have an immediate incidence on the prices and profitability of exports and importcompeting goods relative to other products, exchange rates are widely used measures of competitiveness. Cost and price indicators measure either the extent to which traded goods and services can compete with those of other countries, or the extent to which production of traded goods and services is attractive relative to the production of nontraded goods and services. To measure these costs we use a variety of exchange rate indicators, including real effective exchange rates based on consumer price indices and labor costs, internal exchange rates, and unified exchange rates compared to partners. Exchange rates Real effective exchange rates The 1994 devaluation helped to make the CEMAC and WAEMU countries more competitive. It was followed by a steady Table 1. WAEMU and CEMAC: Real Effective Exchange Rate and appreciation of the REER (Table 1, Components and Figures 12a and 12b). 12 Since then, the CEMAC REER appreciated cumulatively by about 32 percent through December 2 WAEMU and by another 21 percent from Real effective exchange rate Nominal effective exchange rate January 21 to December 26; Relative Price Index by December 26 the CEMAC REER was at 86 percent of its CEMAC Real effective exchange rate predevaluation level. The Nominal effective exchange rate WAEMU REER appreciated by Relative Price Index about 21 percent through Source: IMF, Information Notice System; and staff calculations. December 2 and by another 11 percent from January 21 to December 26; by December 26 the WAEMU REER was at (in percent) Jan Jan Jan 21- Dec 1998 Dec 2 Dec The regional aggregate REER for CEMAC and WAEMU were constructed using weighted averages of the individual countries REERs. The weights are based on nominal GDP.

15 13 77 percent of its predevaluation level. For both the WAEMU and CEMAC the most recent appreciation was essentially due to the strengthening of the Euro to which the CFA franc is pegged. 13 There are significant variations around the regional averages among member countries of each region (Figures 13a and 13b). Within WAEMU, Benin has experienced the highest appreciation since the 1994 devaluation and Mali the lowest. By December 26 Mali s REER stood at 66 percent and Benin s at 89 percent of the predevaluation levels. In the CEMAC, there was a much wider variance of REERs partly because of the new oil producers. At end-26, Equatorial Guinea had the highest appreciation (116 percent of the predevaluation level) and Gabon the lowest (7 percent). Internal real exchange rate The internal real exchange rate (IRER) can be an appropriate measure of competitiveness for small economies where the cost of production is reflected in the price of nontradable goods and the price of imports is determined in the world market. It is measured as the ratio of the prices of nontraded goods (P NT ) to those of tradable goods (P T ). This in itself presents a difficulty because there is no straightforward definition of what are tradable and what are nontradable goods. For a robustness check of our results, we use two different approaches used in the literature (denoted as IRER 1 and IRER 2 ). 14 In the CEMAC fluctuations in the IRER followed those of the CPI-based REER but with wider amplitude; for the WAEMU the IRER was in line with the CPI-based REER (Figures 14a and 14b). In the case of CEMAC, the IRER suggests slightly more erosion of competitiveness than is suggested by the CPI-based REER. Specifically, by end-26 the total cumulative yearly appreciation of the IRER since 1994 was about 11 percent, bringing it to 91 percent of its predevaluation value, while the CPI-based REERs was 86 percent above its predevaluation value. 15 For the WAEMU, the IRER measures track the CPI-based REER very closely until about 23, suggesting that the CPI-based REER captures the costs of production adequately. After 23 the CPI-based REER seems in a sense to overestimate the erosion of competitiveness, because both the IRER measures are below the REER. 13 For CEMAC, the three main trading partner countries and their weights were France (.29), United States (.11), and Germany (.9). For WAEMU, they were France (.27), Germany (.1), and the United States (.9). 14 Details on the calculation of the IRER using two alternative methodologies are presented in Appendix A. The same methodology was applied in Central African Economic and Monetary Community: Selected Issues, IMF Country Report No. 5/ For both WAEMU and CEMAC total cumulative yearly appreciation of the IRER is calculated as a simple average of the two measures of IRER.

16 14 Figure 12a. CEMAC: Exchange Rates and Relative Prices (Index 1993=) Figure 12b. WAEMU: Exchange Rates and Relative Prices (Index 1993=) NEER REER Relative Price Index NEER REER Relative Price Index 12 Figure 13a. CEMAC: Real Effective Exchange Rates of Member Countries (Index 1993=) 12 Figure 13b. WAEMU: Real Effective Exchange Rates of Member Countries (Index 1993=) Cameroon Central African Rep. Chad Congo Gabon CEMAC Equatorial Guinea Benin Burkina Faso Côte d'ivoire Guinea-Bissau Niger Togo WAEMU Senegal Mali 16 Figure 14a. CEMAC: Internal Real Exchange Rate vs. Real Effective Exchange Rate (Index 1993=) 11 Figure 14b. WEAMU: Internal Real Exchange Rates vs. Real Effective Exchange Rate (Index 1993=) IRER1 IRER2 REER IRER1 IRER2 REER

17 15 Labor costs and other real exchange rate measures Labor cost based REERs have remained below the CPI-based REERs in both CEMAC and WAEMU (Figures 15a and 15b). 16 CEMAC s labor-cost-based REER depreciated much more than the CPI-based REER after the devaluation and has remained lower at about 62 percent of 11 Figure 15a. CEMAC: CPI-Based vs. Labor Cost-Based REER (1993=) 11 Figure 15b. WAEMU: CPI-Based vs. Labor Cost-Based REER (1993=) Labor Cost-Based REER CPI-Based REER Labor cost-based REER CPI-based REER its predevaluation level. The WAEMU labor-cost-based REER followed a similar pattern up to 23 but since then has been appreciating faster than the CPI-based REER, suggesting that recently labor costs in WAEMU have been rising faster than prices. Overall, with the exception of WAEMU after 23, labor-cost-based measures suggest that for both regions competitiveness in international markets appears to be more favorable when cost-based rather than CPI-based REERs are used. Particularly for the case of CEMAC, the finding that CPIbased REER appreciated more than the labor cost-based REER could be an indication of Dutch disease. In addition, for both regions, the stronger depreciation of the labor-cost based REER compared to the CPI-based REER suggests that there was a downward adjustment of nominal wages. The service-sector-deflator-based REERs give a somewhat different picture. It has been lower than the CPI-based REER in the CEMAC (Figure 16a) but above it in the WAEMU region (Figure 16b). 16 Because of data limitations, labor-cost-based REER is proxied by the CPI-based REER multiplied by the real wage index (= nominal wage index/cpi). This proxy is our best approximation because there is little if any reliable data on labor costs for many trading partners.

18 16 11 Figure 16a. CEMAC: CPI vs. Tertiary Deflator based REER (1993=) 11 Figure 16b. WAEMU: CPI vs. Tertiary Deflator-Based REER (1993=) Tertiary Deflator based REER CPI-based REER Tertiary deflator-based REER CPI-based REER Sources: IMF, World Economic Outlook database; and staff estimates and projections. Sources: IMF, World Economic Outlook database; and staff estimates and projections. Unified regional exchange rates As a robustness measure of the (CPI-based) REER, we treat each region as an economic unity and measure the international price competitiveness of the common currency 11 Figure 17a. CEMAC: union. As for the Euro area, we construct a Nominal Effective Exchange Rate (Index 1993=, 2-4 weights) measure of the unified regional exchange Rest of SSA rate (URER) in both nominal and real 9 (right scale) terms (URNEER and URREER). These 8 aggregated indicators are constructed so that individual country domestic prices are 7 weighted by the trade between the Total NEER monetary union as a whole and the rest of the world, thus excluding (by construction) intra-union trade, which in some cases might bias the regional European Union competitiveness indicator We also decompose URERs between partners to observe any specific patterns. 11 Figure 17b. CEMAC: Real Effective Exchange Rate (Index 1993=, 2-4 weights) Average URNEER for CEMAC now Rest of SSA stands at about 6 percent of its 9 predevaluation level at end-26 (Figure European 17a). It reached its minimum in 2, 8 Union when the URNEER was at about 5 percent of its 1993 level. Including the effect of relative prices, the CEMAC URREER appreciated about 28 percent from 1994 to 26 and is now at about 83 percent of its predevaluation level (Figure Total REER Details on the calculation of the UREER are presented in Appendix B. For more details see Ramirez and Tsangarides (27)

19 17 17b). Immediately after the 1994 devaluation, the CEMAC URREER appreciated to about where it was at the end of 26, but it depreciated from December 1995 to October 2 before turning around for four years of significant appreciation (21 percent from its low in 2 to December 24); there has since been no clear trend. Due to the peg to the Euro, the URREER relative to the European Union is less volatile than total URREER. The end-26 levels of the CEMAC URNEER and URREER are both consistent with the NEER and REER. The WAEMU URNEER has appreciated by about 3 percent since 1994 and is currently at 8 percent of its predevaluation level (Figure 18a). By 27, its URREER was at about 72 percent of the predevaluation level (Figure 18b). There was significant appreciation in the two years after devaluation, but the index has been fluctuating since around a relatively stable mean. Unlike the URRER compared to the EU, the WAEMU URREER compared to trade partners in SSA is more volatile, and there were episodes of extreme depreciation in February 1995 and in January Comparing to the conclusions based on the WAEMU NEER and REER, at the end of 26, the URNEER was about 2 percent higher than the NEER, and the URREER was about 5 percent lower than the REER Equilibrium real exchange rates Assessing competitiveness and necessary exchange rate or other appropriate policy action also requires a quantitative analysis of the actual and equilibrium exchange rate (EREER). While this paper does not explicitly analyze the movements of the REERs of the two monetary unions of the CFA franc zone vis-à-vis their long-run equilibrium values, we can draw conclusions based on the recent work by Abdih and Tsangarides (26). Using the fundamentals equilibrium exchange rate (FEER) approach based on the Edwards (1989) model and the Johansen (1995) cointegration methodology, the authors identify certain fundamentals that account for most of the fluctuation of the real effective exchange rates: increases in the terms of trade, government Figure 18a. WAEMU: Nominal Effective Exchange Rate (Index 1993=, 2-4 weights) 5 European Union Figure 18b. WAEMU: Real Effective Exchange Rate (Index 1993=, 2-4 weights) Rest of SSA (right scale) Total NEER consumption, and productivity improvements tend to cause the exchange rate to appreciate, while increases in investment and openness lead to a depreciation. Based on these fundamentals, Abdih and Tsangarides estimate that while both the WAEMU and CEMAC real exchange rates Total REER Rest of SSA European Union

20 18 were slightly more appreciated than their estimated long-run equilibrium levels at end-25, the estimated misalignments were not statistically significant. This sugegsts that at end-25 both the CEMAC and WAEMU real effective exchange rates were broadly in line with their long-run equilibrium values. 18 Labor costs and wages Given the lack of reliable data on total production costs in the two regions, the analysis focuses on labor costs. Since there is no first-hand data on the wage rate of the countries as a whole (including the private sector), we use an index of wage rates of civil servants as its proxy. 19 We then construct a nominal wage index for each country in the zone using data on total wage and salary expenditures of the government, together with the number of civil servants (for WAEMU) or the population (for CEMAC, where data on the number of civil servants is not available). We proxy real wages by the ratio of the nominal wage index to CPI. Nominal wages tend to have grown slower than other domestic prices in most countries in both zones. By the end of 26, CEMAC countries showed a similar decline in the real wage index except Equatorial Guinea (where government expenditures increased sharply with oil revenues) and Gabon (Figure 19a). In the WAEMU real wages in 26 were lower than in 1993 in Burkina Faso, Côte d Ivoire, Niger, and Togo but through 23 had risen in Benin, Mali, and Senegal (Figure 19b). The decline in real wages was most noticeable at the time of the devaluation, because exchange rate pass-through to wages is weaker than pass-through to other prices Further, in the context of the IMF s 27 Article IV discussions, the analysis of Abdih and Tsangarides (26) was extended for both the WAEMU and CEMAC EREERs up to 26 (see SM/7/119 and SM/7/212). This work concludes that in 26 also the levels of the real effective exchange rates were in line with the estimated equilibrium real effective exchange rate paths, without any statistically significant misalignments. 19 The analysis focuses on the wage index (and consequently the rate of change in wages), not the wage level. This allows us to explore the evolution of wage rates over time without needing information on the wage level in the private sector (or the ratio of public sector to private sector wages). An index based on civil servant wages should capture well the movement of wage rates of the economy as a whole as long as public and private sector wages tend to move together (which is likely at least over the long term). 2 Unit labor costs (that is, labor costs adjusted for labor productivity) would have been computed had reliable data been available. Since it was not, we resorted to per capita GDP as a proxy for labor productivity.

21 Figure 19a. CEMAC: Real Wage Index (1993=) Figure 19b. WAEMU: Real Wage Index (1993=) Cameroon C.A.R Chad Benin Burkina Faso Côte d'ivoire Congo, Rep of Gabon Eq. Guinea (right) Niger Mali Senegal Togo Sources: IMF, World Economic Outlook database; and staff estimates and projections. Sources: IMF, World Economic Outlook database; and staff estimates and projections. In summary, the various real exchange rate measures point to an appreciation of the CFA franc in both WAEMU and CEMAC, suggesting a loss of competitiveness. However, the constructed nominal wage indices show that nominal wages have grown slower than other domestic prices in the majority of the countries in both regions. C. Macroeconomic Performance Macroeconomic performance indicators measure the evolution of export flows and market shares, as well as foreign direct investment (FDI) flows. Strong export growth (if not associated with equally strong import growth), expansion in export market shares, and increasing export diversification suggest improved competitiveness. Such trends are also associated with increasing profitability of exports, measured as falling unit costs or increasing value-added. FDI flows also reflect the attractiveness of a country s investment climate and tend to be correlated with increases in exports. Export patterns and market shares Since 21, CEMAC shares of the export market to the world have been increasing, to Africa declining, and to the EU roughly constant (Figure 2a). 21 Intra-CEMAC trade has been virtually flat at about 1 percent since 2. Over the same period, WAEMU market shares to the world appear to be increasing, and for Africa and the EU decreasing (Figure 2b), but intra-waemu exports have been expanding and are much higher than intra-cemac exports. 21 Shares defined as the ratio of a region s total exports to the total imports of selected groups.

22 2.6.5 Figure 2a. CEMAC: Ratio of Exports to Selected Groups' Total Imports Figure 2b. WAEMU: Ratio of Exports to Selected Groups' Total Imports (in percent) To European Union To US To World To Asia To Africa To European Union (left scale) To World (left scale) To US (left scale) To Africa (right scale) Sources: IMF, Direction of Trade Statistics; and staff estimates and projections. Sources: IMF, Direction of Trade Statistics; and staff estimates and projections. The evolution of the exports to GDP ratio and the volume growth rates for CEMAC are shown in Figure 21a and for WAEMU in Figure 21b. For WAEMU, exports-to-gdp have been increasing and since 2 volumes (although volatile) have been growing by an average of 2 percent. For the CEMAC region, export performance has been dominated by the oil sector, as is evident by the increase of both the share and volume of oil exports. Since 1997 there has been a decline of non-oil exports to GDP, though they began to pick up in 25. In comparison to Figure 21a. CEMAC: Export Patterns (in percent) Figure 21b. WAEMU: Export Patterns (in percent) Oil Exports to GDP (left) Real oil export growth (right) Non-oil Exports to GDP (left) Real non-oil export growth (right) Exports to GDP (left) Real export growth (right) Sources: IMF, World Economic Outlook database; and staff estimates and projections. Sources: IMF, World Economic Outlook database; and staff estimates and projections. export shares of other groups, CEMAC average exports-to-gdp in 21 6 are higher than in Latin America, SSA, and OECD, and almost at the level of emerging Asia. At about 31 percent, WEAMU s average export shares are below SSA generally but compare favorably to the other comparator groups (Figure 22). FDI and diversification FDI flows to developing countries are good sources of non-debt-creating capital, offering access to advanced technology and global marketing networks. FDI flows (and stocks) to developing countries vary because countries differ in their ability to attract FDI, depending on their market size, labor costs, and human capital and technology. Figure 23 shows that emerging Asia has

23 21 attracted the majority of FDI US$1.4 billion in 25, almost twice as much as the next developing country group, Latin America. While FDI in both WAEMU and CEMAC is low in dollar terms, it has been significant as a share of GDP (Figure 24). FDI in CEMAC has been steadily increasing, surpassing other SSA countries since 21, primarily due to oil-related investments; it amounted to about 4 percent of the region s GDP in 25. In WAEMU FDI has been flat at about 15 percent of regional GDP since about 2. In SSA as a whole FDI has been declining since 23; in 25 it was 3 percent of GDP. As a comparison, FDI flows represent about 2.5 percent of GDP in lowermiddle-income countries, 3. percent in Latin America, and 2.4 percent in East Asia and Pacific; 3.2 percent in SSA as a whole; 7.1 percent in CEMAC; and just.9 percent in the WAEMU. Loss of competitiveness may be due to patterns of specialization. We examine this possibility by comparing the evolution of the growth of market share of WAEMU exports in 2 5 with the evolution of world export prices. We perform the analysis only for the WAEMU because in the CEMAC all export developments are dominated by oil. The bottom two quadrants of Figure 25 identify commodities whose prices increased less than average export prices. The two right quadrants identify areas where WAEMU export growth was higher than the world average. The size of the bubble reflects the importance of the commodity OECD Figure 23. Foreign Direct Investment (US$, billions) Emerging Asia OECD (Right scale) CEMAC Latin America Sub-Saharan Africa WAEMU Source: UN UNCTAD; and IMF, World Economic Outlook. Figure 24. Foreign Direct Investment (Percent of GDP) Other SSA Figure 22. Exports of Goods and Services (Percent of GDP) Emerging Asia South Africa Latin America CEMAC WAEMU Source: UN UNCTAD; and IMF, World Economic Outlook. SSA CEMAC WAEMU Source: IMF, World Economic Outlook; and African Department database

24 22 inwaemu trade. The figure makes it clear that, excluding fuels, cocoa, and iron, for 2 5 the average growth in exports in US dollars of the products that WAEMU countries export was below the overall average for total world exports. In addition, for all these products, average price increases were lower than the world export average. In contrast, in the markets for cocoa and iron export price increases have been higher than average, and higher than average export growth. The weight that cocoa has in the Price increase in world exports Figure 25. WAEMU: Export Performance by Product, 2-5 (Percent, bubbles reflect relative size of exports) Fertilizers WAEMU trade is what is driving explains WAEMU export performance; the other sectors have not been doing so well. In summary, export volumes show improvement in both regions, dominated in the CEMAC by the oil sector. Export growth for WAEMU was much slower than for CEMAC but showed some diversification. Export market shares have been increasing in some markets and worsening in others. FDI has been increasing in CEMAC and compares favorably with the rest of the SSA, but has stagnated for WAEMU. Fuels Iron Fish Chemicals 5 Coffee Fruits Cocoa Minerals 4 8Cotton Average export price increase Source: UN COMTRADE. Average export growth Annual growth in world exports Profitability V. POLICY A. Business Environment The profitability of exports in CEMAC has been driven by the oil sector, where profitability is driven by fluctuations in oil prices fluctuation, which have been rising in recent years. Figure 26a shows that the impact of the appreciating REER was somewhat contained over the past two years, as CEMAC exports increased, terms of trade improved due to oil price increases, and export profitability generally was enhanced. Figure 26b shows an overall deterioration of the terms of trade for WAEMU since about 1995, coupled with an appreciation of the REER, which suggests challenges export competitiveness and profitability, while, at the same time, there was an overall improvement of the export index.

25 Figure 26a. CEMAC: Terms of Trade, Real Oil Price and Exchange Rates (Index 1993=) Figure 26b. WAEMU: Terms of Trade, Export Prices and Exchange Rates (Index 1993=) Real Oil Price (left scale) REER (right scale) TOT (right scale) Export Price Index (right scale) NEER TOT Export Price Index REER TOT non-oil (right scale) Sources: IMF, World Economic Outlook database; and staff estimates and projections. Sources: IMF, World Economic Outlook database; and staff estimates and projections. While overall export and oil export profitability have been improving, there is evidence of an erosion of the profitability of non-oil exports in CEMAC. We therefore construct two direct measures of profitability, the export price index-to-tertiary GDP deflator and the export price index-to-wages deflator. For CEMAC, we also construct oil and non-oil indices to investigate the profitability of each sector separately. Both indices (Figures 27a and 28) show clearly that Figure 27a. CEMAC: Profitability Indicator Export Price Index/Wage Index (Index 1993=) Export Price/Wage (left) Non-oil Export Price/Wage (right) Oil Export Price/Wage (left) Figure 27b. WAEMU: Profitability Indicators (Index 1993=) Sources: IMF, World Economic Outlook database; and staff estimates and projections. Sources: IMF, World Economic Outlook database; and staff estimates and projections Export/Wage Export/Tertiary GDP while the profitability of exports generally has been increasing in the last two years, this is driven by the oil sector; non-oil-sector Figure 28. CEMAC: Profitability Indicator 25 Export Price Index/Tertiary GDP Deflator profitability has been steadily declining (Index 1993=) 225 since 2. For WAEMU (Figure 27b), the indices show (on average) a net decline in 2 profitability since Survey-based indicators of the business environment Survey-based indicators of the business climate and governance are useful measures of the indirect costs of production, such as Export/Tertiary GDP Oil Export/Tertiary GDP Non-oil Export/Tertiary GDP Sources: IMF, World Economic Outlook database; and staff estimates and projections.